The Centre is not likely to accept the demand made by foreign banks operating in India for tax deduction at par with that of domestic public and private sector banks.

Domestic banks have an option of claiming tax deduction to the extent of 7.5 per cent of their total income or 10 per cent of their non performing assets to be set off against their total corporate tax liability.

Foreign banks' wish list

Allow provisioning for NPAs at par with that of domestic banks

Allow deduction from interest income on foreign currency loans for expenditure incurred on such income

Reduce corporate tax rate on branches of foreign banks to the general rate

But foreign banks get a lower tax deduction for their NPA load of up to 5 per cent of their income. The banks have represented to the finance ministry that this is against the concept of level playing field.

According to ministry officials, the higher tax deduction for domestic banks, both in public and private sectors, is based on the fact that they have to meet priority sector lending norms.

Under the Reserve Bank of India rules, 40 per cent of the total advances made by such banks should be for the priority sector. Of this, 18 per cent is for agriculture and allied activities.

The ministry officials said since these lendings carried a higher risk of default, they increased the gross NPAs of the banks. So it was only fair that the same be given a higher tax deduction.

On the other hand, foreign banks did not have to meet such norms, the sources said and added that unless the priority advance norms were altered, there was no ground to level the playing field.

In Budget 2002-03, the ministry had enhanced the tax deduction rates to the present level from the earlier five per cent ceiling for domestic banks.

However, reacting to the issue, Shyamal Mukherjee, partner at PricewaterhouseCoopers, said the discrimination was not based on the principles of taxation. He said the provisions under section 36(I) (viia) of the Income Tax Act, 1961 should therefore be amended.

Managing NPAs has become a major issue in banking reforms. The RBI and the finance ministry have been nudging domestic banks to reduce their NPA overhang to improve their profitability. The tax incentive is one of the sops being held out by the ministry to make the banks fall in line.

The Kelkar committee on direct taxes had, however, recommended that an expenditure should be an allowable deduction only if the liability was crystallised.

Therefore, any provisioning for an expenditure is not an allowable deduction if such provisioning is not a statutory deduction.

It had therefore recommended that section 36(I) (viia) of the IT Act should be amended to make provisioning for bad debts restricted to the maximum provisioning allowed under the Reserve Bank of India rules.